The following is a guest post from Mike Corley, Risk Consultant, founder and president of Mercatus Energy Advisors.
How does one develop an energy risk management policy when nothing of the like currently exists within the organization? Start by defining the purpose(s) of the policy. As an example, the purpose of an oil and gas producer’s risk management policy might read as follows:
- To ensure continuity of exploration and production in adverse market conditions
- To guarantee that revenue and cash flow are sufficient to service debt
- Seek opportunities to increase revenue and cash flow, while reducing risk, by restructuring or liquidating existing hedge positions.
As another example, an industrial consumer’s (manufacturing, processing, etc.) purpose for having an energy risk management policy might read along the lines of the following:
- To mitigate our exposure to volatile diesel fuel and natural gas prices
- To ensure that our diesel fuel and natural gas costs remain within budget
- To guarantee that our exposure to diesel fuel and natural gas price volatility is not a factor that could cause a significant competitive disadvantage
Next define the who, what, how, why and when…
Who is going to be responsible for ensuring that the company follows the policy and what checks and balances need to exist?
Who is responsible for developing, implementing and managing the hedging strategy(s)? A hedge committee, CFO, third-party consultant? Do they need additional, internal or external resources?
What transaction type (i.e. futures, swaps, options, etc.), volume, tenor (time frame) and financial exposure (gross and net) are within the company’s risk tolerance?
How will financial exposure be measured and by whom? VaR, CFaR (cash flow at risk), another metric of some sort?
When will the first trade be executed and why? When and how will the positions be reviewed to ensure that they are still appropriate given the company’s risk tolerance, hedging policy and market conditions?
Who is responsible for executing trades?
Who is responsible for FCM (futures commission merchant) and/or counterparty selection and approval and what criteria will be used to evaluate FCMs and counterparties? What about monitoring counterparty credit exposure?
Who is responsible for position reporting? What are they to report, how often and to whom?
Clearly there are a lot of issues to be explored when developing an energy risk management policy but hopefully this provides a good understanding of the types of questions that need to be asked and answered when developing the initial policy. If you need assistance developing your company’s energy risk management policy, please contact us. ____________________________________________________________________________________
Mercatus Energy Advisors is the leading, independent energy hedging and risk management advisory firm. The firm’s client base includes energy consumers, producers, marketers, refiners, and traders as well as financial institutions, institutional investors and professional services firms.
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